Pulse rate: Almost back to normal

A business mentor of mine once said there are three types of people in the world: (1) those who make things happen; (2) those who watch things happen; and (3) those who say What the hell happened?  On Friday, Fed Chairman Ben Bernanke made good things happen, and CNBC was helping me watch them closely.  What a thriller. 

After the late-week excitement on the monetary front, Bernanke's decisive Friday morning action and its aftermath helped bring my pulse rate back down to near-normal ...but, admittedly, I need to see another day's action on the 13-week T-bill and the fed funds rate before it's all the way back down. 

The Fed chairman did the right thing at just the right time (lowering the discount rate).  Jim Cramer, CNBC's famous wildman, estimates that it prevented a thousand point plummet in the DJIA.  I have no idea how to gauge whether that's accurate, but I do know the pundits were nearly unanimous the previous evening (Thursday) that the liquidity crisis was serious indeed.  I did hear that Bernanke's action just before the opening bell the next morning, on option-expiration Friday, put some index fund short-sellers out of business within a few minutes.  [When you're a short seller committed to down 500 at the open, up 300 is a killer, literally.]  It still looks to me as if Fed action early Friday just might have prevented a freeze-up of the banking system.  Three cheers for Bernanke. 

And a big hat tip from me to the CNBC tag team—especially Erin Burnett, Mark Haines, Maria Bartiromo, and Larry Kudlow—who stayed right on top of these events the whole time, mornings through evenings.  They were asking the right questions at the right times, and they gained at least one loyal listener for CNBC: me.  You should take a peek at them every now and then, too, if you don't already. 

For me, last week's monetary events served as a stark reminder that those gradual, linear-looking trends many of us overstudy and pontificate about are occasionally interrupted—very rudely—€”by vertical spikes of discontinuity.  Some spikes are positive, some are negative, but all are nearly-instantaneous.  I have a feeling our Fed chairman preempted what otherwise would have been a nasty day for our economy on Friday.  Just an educated guess.

Comments

[dave]

History is made up of events which are non-linear. It was an interesting week.

[mark]

Steve,
You often point to Wesbury as an economic expert. He continues to call for the Fed to raise rates. What's your take on him?

[Steve]

Mark,

Wesbury is one of my favorite pundits; that hasn't changed. He understands the importance of growth, understands its causes and its enemies, and has a rare ability to put it into plain talk so the rest of us can get it. Just about the only place where we differ is on the inflation question, and measuring inflation still seems more of an art than a science; one has a smorgasbord of choices as to what to include and exclude in the number. Brian includes food and energy, which has been yielding a higher reading than "core" inflation, which excludes those. I've come to like the Dallas Fed's "trimmed mean" inflation calculation on personal consumption expenditures, which has been closer to core inflation. (The history jumps around more than I'd like whenever GDP is revised, but you can't have everything).

I also think the deflation in asset prices (housing) will be a nontrivial offset to consumption price inflation; in fact, the Fed's recent move just might be a tacit admission that they weren't paying quite enough attention to the asset deflation (disinflation?) issue.

Brian and I both hold sound money as a high priority for the economy's well-being. (In fact, I can't think of many who don't.) Measuring inflation, and even whether we have inflation or deflation, is the hard part. There's a wide array of opinions as to the best way of measuring it, and Brian and I happen to be in two different places on the list of possible measures. However, we have little to no disagreement as to what to do about inflation or deflation, once it's been determined.

[Bob]

I go a little bonkers about the measurement of inflation. It shouldn't be an uphill battle to come up with a consensus measurement. My heavens! If we're trying to contain it and can't even come up measurements that have agreement then personal bias dictates action. That's scary.

The latest boogeyman appears to be the employment figures. Somehow Bernanke must be spooked that COLA raises employers doled out in the late seventies and early eighties will return. Gimme a break! I remember quite well when a 7% raise was the norm and it ain't happening. It's all about pay for performance and productivity. Furthermore, businesses just don't have the pricing power they used to.

Steve, if you're looking for any help from this Fed on a growth economy, forget it. They're very content to plug along at a 2 - 2.5% real rate.

[rg]

Steve, I am a bit confused. Isn't it just so that the Fed by buying a real or perceived "loss" from the market with borrowed, printed and taxed money, it has just distributed this loss over more people and therefore made it less recognizable.

Somebody still pays for it. Please explain if I got this wrong.

rg

[mark]

Steve,
The Fed provides the banking system with reserves. If the Fed does not provide sufficient reserves the Fed funds rate will increase (as banks short of reserves will bid up the rate) until the Fed funds rate reaches the discount rate. You graph shows a steady Fed funds rate prior to the Fed action; so I fail to see the liquidity crisis in the banking system. All I see is the Fed deciding to cut the Fed funds rate without officially changing the target. If the Fed funds rate was steady, exactly what was the "crisis"?

[Brad S]

Mark, if you look at his post a few days ago, you will see that the Fed Funds rate did go down. It just didn't go down as much as the T-bill rate did.

This is one big reason why there'll be a Fed Funds rate cut on 9/18.

[Brad S]

Steve, did you happen to see Brian Wesbury's latest statement on the credit markets:

http://www.ftportfolios.com/Commentary/EconomicResearch/2007/8/20/Bernanke_Resists_Hair_of_the_Dog

If he's correct in saying that last week's level of commercial paper issuance was 38% above last years, we need more information on just what went on these last 2-3 weeks before that Fed Funds rate cut happens.

[Bob]

Mark,

Check out this blog from time to time. Steve has it listed under Prof. J.D. Hamilton.

On liquidity:
http://www.econbrowser.com/archives/2007/08/what_is_a_liqui.html

And fed funds:

http://www.econbrowser.com/archives/2007/08/another_roller.html

[Steve]

[oops, I posted this to the wrong article an hour ago...]

rg:
The Fed isn't assuming any loss; they buy only the highest quality bonds/bills/notes, most if not all government-backed such as T-bills, from the private sector. Picture new dollars created by the Fed moving into the private sector, to pay for the bonds the Fed is buying from the private sector. Many of those transactions were "repurchase" agreements, which means the private sector agrees to buy those bonds back at the end of a specified time period. The net effect is a temporary injection of liquidity (cash) by the Fed into the private sector.

mark:
The Fed saw the liquidity crunch, and injected so much extra reserves that the fed funds rate fell, and has stayed, below the Fed's advertised target of 5.25%. When the banks have insufficient reserves to make even the safest short term working capital loans to the safest companies, the danger is a banking system freeze-up. That's not a credit-quality crunch, it's a liquidity crunch.

Half of the pundits say the Fed will adjust the reserves to get it back up to 5.25%; the other half of them say the Fed has almost no choice but to lower the target to 5.00 or 4.75%. Interestingly, all of the pundits I'm talking about are ex Fed folks. There's a diverse array of opinions even in that crowd.

When I look at the plunging rate on the shortest-term treasuries (1-month and 13-wk T-bills), and the huge gap that creates with the fed funds target, I have to lean with those who predict the Fed will have to lower the advertised target rate (to square with their defacto lowering of the actual rate, as shown at this page from the NYFRB: http://tinyurl.com/54c7j ).

Caution: I am a terrible predictor of interest rates, and should probably stop trying. Everybody should go read Brian Wesbury's latest take for a balancing viewpoint; it's in this document: http://tinyurl.com/258vy7

Again, however, I will be keeping a close eye, daily, on the fed funds rate at this page: http://tinyurl.com/54c7j , and also on the 1-month and 13-week T-bill rates. Psychology (i.e., fear) has been ruling the action in the last few days, and those interest rates are an indicator. The lower the 13-wk T-bill rate, the higher the demand for safety. The bigger the gap between that and the target fed funds rate, the more the pressure for the fed to lower the target.

Brad:
We must have read Brian's paper simultaneously.

[Kevin]

Steve posts pictures of Erin Burnett and Maria Bartiromo, and all you guys can talk about are interest rates? Sheesh

[benson]

Kevin: haven't you heard? Gentlemen prefer bonds!